Abstract ¶

NPA stands for Non-Performing Asset. A Non-Performing Asset (NPA) refers to a classification for loans on the books of financial institutions that are in default or are in arrears on scheduled payments of principal or interest. In most cases, debt is classified as nonperforming when loan payments have not been made for a period of 90 days.

The rate of NPA in Indian Banks has seen a surge in recent years. As per data provided by RBI, the total NPA of Indian Banks were Rs 248,200 Crore in the Financial Year 2014-15 and Rs600,000Crore during the Financial Year 2015-16. Out of this massive amount, Rs 30,800 Crore (12.4 per cent) could be recovered in 2014-15 and Rs 22,800 Crore (10.3 percent) could be recovered in 2015-16.NPAs have almost doubled in the last 15 months. From Rs 3,40,556 Crore in September 2015, bad loans have risen to Rs 6,68,825 Crore in September 2016, largely due to the classification requirement of the RBI. Large business groups like KingfisherAirlines have defaulted to the tune of Rs 9,000 Crore and Winsome Diamonds have defaulted to the tune of Rs 7,000 Crore. Demonetization has also made the recovery process more complicated.Will the growth in Indian Economy get stalled with less availability of credit? Will it lead to a higher amount of stress in Small and Medium Enterprises (SME) Sector? Is the creation of a centralized ‘bad bank’ a logical solution to the impending crisis? This research paper seeks to explore the effect of rising NPAs in Indian Banks and the consequent challenge that it is likely to pose for the growth of Indian Economy along with possible solutions to the same.

Keywords: Non-Performing Assets, Indian Banks, GDP Growth.

The problem statement ¶

The Indian Economy grew at a rate of 3.5% between 1950 to 1980, 5.6% between 1981 to 1990 and 6.2% between 1990 and 2000. The real acceleration came in the new millennium when the GDP grew at a blistering pace of 9% annually between 2005 and 2008. The GDP growth rate touched a high point of 11% in 2003 and 9.4% in 2007. All these happened despite the challenges posed by the Harshad Mehta Scam, Ketan Parikh Scam, the South East Asian Crisis and the Subprime Mortgage Crisis.

The economy got a boost due to the liberalization, privatization and globalization reforms brought about by the Narsimha Rao – Manmohan Singh Government commencing from 1991. The adoption of Narsimhan Committee recommendations and the implementation of the SARFAESI Act gave a further boost to the Economy and the Banking system. Liquidity was infused into the banking system by reducing the CRR (Cash Reserve Ration) and the SLR (Statutory Liquidity Ratio) and empowerment was provided through the SARFAESI Act that empowered banks to recover dues from loan defaulters by acquiring their assets and selling them. The banks also started showing a healthy growth from 2001 onwards.

However, the whole scenario has changed in the last few years. Banks are now saddled with Non-Performing Assets created by willful defaulters who have absolutely no intention of repaying the huge loans advanced to them by the gullible bank managers. As per data given by All India Bank Employees Association(AIBEA), a total of 5,610 willful defaulters have collectively defrauded public sector and private sector banks in India of a staggering amount of Rs. 1.86 lakhCrore as on March 2016.

What is the solution to this problem that hangs around like an albatross around the neck of the banks? Should they put a restriction on loan disbursal to curb the growing menace of NPAs? Should they adopt a stringent due diligence system? Should they just simply write off the loans as bad debts and wait for the Government and shareholders to recapitalize the treasury? Or should they create a bad bank where all this toxic loans can be dumped to clean off their balance sheets?

This research paper explores the origin of the problem of NPAs in banks operating in India and delves deep to seek solutions that could resolve the issue as well as prevent such unwanted occurrence in the future.

Review of literature ¶

Rathore, D.S, Malpani, Dr.Sangeeta and Sharma, Sunita in their study on Non-PerformingAssets (NPA) of Indian Banking System and its Impact on Economy, inferred that because of mismanagement in banks there is a positive relation between Total Advances, Net Profits and NPA of bank which is not good. Because of an adverse effect on the liquidity of banks, the banks are unable to give loans to the new customers. Their study points out that the main reasons for rise in NPAs are sluggishness in the domestic growth in the recent past, slow recovery in the global economy and continuing uncertainty in global markets leading to lower exports of various products such as textiles and leather.

Another study done by Singh, Asha (2013) titled Performance of Non-Performing Assets (NPAs) in Indian Commercial Banks inferred that the NPAs in public sector banks are growing due to external as well as internal factors. One of the main causes of NPAs in the banking sector is the directed loans system under which commercial banks are required to supply 40% percentage of their credit to priority sectors.

As per a study done by Tracey, Leon and O’Brien (2011) for an IMF Working Paper, a higher NPA forces banks to invest in risk-free investments, thus directly affecting the flow of funds for productive purpose.

All these studies and research papers have pertinentlyobserved that there is a significant effect of NPA (Non-Performing Assets) on the growth rate of a country’s GDP(Gross Domestic Product). Our research paper does an in-depth study on how this problem was created and seeks solutions to resolve the issue.

Research Methodology ¶

The methodology used here is descriptive research using secondary data. A sample study was done on 50 Banks comprising of Public Sector Banks (PSB) and Private Sector Banksto understand how the NPA problem has affected the solvency and credit off-take at Banks and what strategies the banks have taken to reduce the NPA Problem. The top 50 banks were chosen as per the total assets under management. A list of the banks has been given in the Appendix. The time period of the study is 1991 to 2015. The data has been analyzed using case study analysis to draw inferences from logical analysis. The information used is secondary data collected from journals, magazines, newspaper articles and authentic research papers.

Introduction to Banking system in India ¶

Banks have been the mainstay and supporting backbone for most of the industries nationally and globally since time immemorial. From the time the barter system was replaced with monetary system, banks have played a key role in treasury management, working capital management, investment management, project financing and several key activities. Today, the global banking industry does business worth $410 trillion every year with more than 15,000 banks taking active part in financial transactions.

As per information provided by Reserve Bank of India (RBI), there are presently 26 public sector banks, 20 private sector banks and 43 foreign banks that have been given the permission to undertake banking operations in India. Another two entities, IDFC(Infrastructure Development and Financing Corporation) and Bandhan, which was earlier a micro-finance company, have recently got banking licenses. Apart from that, there are also regional rural banks and cooperative banks. The banking sector in India has a net worth of Rs 81 trillion ($1.31 trillion). As per research done by KPMG and CII, the banking industry in India is all set to become the fifth largest banking industry in the world by 2020 and the third largest by 2025. (Figure 1)

The financial deregulation in India received a major thrust with the implementation of liberalization-privatizationglobalization policy by the Narsimha Rao - Manmohan Singh Government in 1991. The Narsimhan Committee set up by the Indian Government in 1991 gave key recommendations for increased autonomy of Public Sector Banks, which were later adopted by the policy makers. Subsequently, a second committee set up under the stewardship of MrNarsimhan in 1997 advocated the healthy competition between private sector and public sector banks.

The growth story of Indian economy (1991-2015) ¶

The Indian Economy has seen a phenomenal growth story from 1991, when the Narsimha Rao - Manmohan Singh Government announced a slew of reform measures under pressure from IMF and World Bank. The Government
opened the doors for foreign companies, abolished the license system for most sectors and also took initiatives for divestment of unprofitable PSUs (Public Sector Units).

The GDP grew phenomenally from Rs5,86,212 lakh Crorein 1990-91 to RsRs 1,35,76,086 Crore ($2.30 trillion) . India has recently surpassed UK whose GDP in 2016 stood at $2.29 trillion.The Indian economy grew at a blistering rate of 9% annually between 2005 and 2008. With a current GDP growth rate of 7.6%, India is the fastest growing economy in the world surpassing that of China.

Table-1 Comparative analysis of Indian economy at 1991 & 2015

	1991	2015
GDP	$480 billion	$2.3 trillion
Foreign Exchange Reserves	$5.8 billion	$315 billion
Foreign Direct Investment (FDI)	$74 million	$63 billion
Foreign Institutional Investment (FII)	$4.2 million	$45.69
External Debt	$83.8 billion	$480.2 billion
BSE Sensex	4000	27000
Per Capita Income	Rs 6,270	Rs 93,293
Unemployment Rate	4.3%	3.6%

The Indian economy has done well in other parameters also. The Foreign Direct Investment (FDI) rose from $74 million in 1991 to $63 billion (Rs 4.19 lakh Crore) in 2015. The country received a total of $371 billion between 1991 and 2015. The Foreign Institutional Investment (FII) rose from $4.2 million in 1991 to $45.69 billion in 2015.

India’s foreign exchange reserves were in a precarious state in 1991. It was just $5.8 billion in 1991, and the country was just barely able to survive the economic shock. Today the foreign exchange reserves stands at a healthy $360 billion. India now has more than sufficient foreign exchange reserves to cover the import bill and balance of payments. However, the external debt of the country has risen from $83.8 billion in 1991 to $480.2 billion in 2015. Although the figure looks alarmingly huge, the external debt as a percentage of GDP has actually come down from 38% in 1991 to 24% in 2015.

On 24th July 1991, when presenting the Union Budget, the finance minister DrManmohan Singh had quoted Victor Hugo and said”No power on Earth can stop an idea whose time has come.” The visionary economist had indeed seen the writing on the wall long before us. Today India is respected as the fastest growing economy in terms of GDP, reclassified from an underdeveloped economy to an economic super power and revered as the rising elephant which can take on the prowess of the mighty USA and China with equal élan.

The origin & growth of NPA in banks ¶

However, the growth of every economy comes with the usual pangs and India had its usual share of troubles. The growth has not been uniform across all regions with states like Bihar, Madhya Pradesh, Rajasthan, Uttar Pradesh (collectively known as the Bimaru States), the North Eastern States and Jammu and Kashmir not growing at the pace in which industrialized states like Maharashtra, Gujarat, Karnataka and Tamil Nadu has grown. There has been infrastructure bottlenecks across the country with huge investments required to build roads, railway tracks, airports, power plants,telecom, hospitals and drinking water facilities. The
disparate growth saw migration of labor from underdeveloped states to the developed cities like Mumbai,
Delhi, Bengaluru, Chennai and Gurgaon which put a tremendous pressure on requirement of civic amenities like housing, sanitation, electricity and drinking water.

It was practically not possible for the Indian Government to carry out the developmental activities on a standalone basis; it needed the active support of private entrepreneurs and corporate bodies. The Government sought to jointly undertake these activities in partnership with private enterprises under the PPP (Public Private Partnership) Model. The sectors identified were telecom, power, highway, airports and other projects that had long gestation periods. The different types of PPP Models and contracts that were formulated were : User fee based BOT(BuildOperate-Transfer) model, Performance based Management Contracts and Turnkey Contracts. The XII Five Year Plan (2012-2017) had outlined an ambitious target of $1 trillion
in infrastructure investment.

Consequently, the investment required in these projects was also substantially high. To ease the problem of capital availability, the Government had specifically asked the banks to lend money to private corporate bodies on liberal terms and conditions. This actually saw a spurt in big, medium and small enterprises entering the fray to avail of bank loans to invest in growth oriented schemes and sectors.
We had the Reliance Group (both MukeshAmbani and Anil Ambani), GMR Group, GVK Group, the JP Associates
Group, Adani Group, and the ill fated Kingfisher Airlines promoted by Vijay Mallya that availed of huge loans that are now threatening to turn into NPA(Non Performing Asset).

Vijay Mallya and Kingfisher Airlines has been in the news for last one year with the banks making desperate bids to recover the Rs 9,000 Crore owed to them. With Vijay Mallya having left the country to seek asylum in UK, things have become much tougher for the banks and recovering agencies. But Vijay Mallya owned Kingfisher Airlines is just one of the many large corporate defaulters who are leading the banking sector into the web of bad loans. There are companies like Winsome Diamonds Rs 7,000Crores), REI Agro (Rs 5,253 Crores), Zoom Developers (Rs3,000 Crores) and many others who have taken large exposure to bank loans and defaulted. The total bad loans of India’s 40- listed banks stood at Rs6 lakh crore in 2016, while total live cases of restructured loans under the corporate debt restructuring (CDR) channel alone stood at Rs 2.6 lakh crore. Bad loans constituted by the top four defaulters in public sector banks is around Rs 23,000 crore. Fresh bad loans in public sector banks in the last seven years is Rs 4.95 lakh crore.

Table-2 Top Bank Defaulters from India

Sl No.	Company	Amount of loan default
1	Kingfisher Airlines	Rs. 9,000 Crore
2	Winsome Diamonds	Rs. 7,000 Crore
3	REI Agro	Rs. 5,253 Crore
4	S Kumar Nationwide	Rs. 4,500 Crore
5	Deccan Chronile	Rs. 4,000 Crore
6	KS Oil	Rs. 4,000 Crore
7	Zoom Developers	Rs. 3,000 Crore
8	Surya Pharmeceuticals	Rs. 1,700 Crore
9	Beta Naphthol	Rs. 950 Crore
10	Electrotherm India	Rs. 436.74 Crore

Among the top three nationalized banks having the highest amount of defaulted loan amount are State Bank of India with the highest value of Gross NPA at Rs 93,000 Crore, followed by Punjab National Bank (Rs 55,000 Crores) and Bank of India (Rs 44,000 Crores). The overall NPA for Public Sector Banks stood at above Rs6 lakh Crore, as on June 2016, as per information given by the Finance Ministry.

Table-3 Top Banks affected by Bank Defaults

Bank	No. of cases	Total amount (Rs. crore)
State Bank of India	1,972	36,105.29
Punjab National Bank	1,032	16,730.34
Canara Bank	1,220	10,016.36
Bank of India	621	9,073.96
Oriental Bank of Commerce	515	8,273.33
Bank of Baroda	906	8,115.89
Corporation Bank	491	7,907.66
Citibank	7	1,333.14
Standard Chartered Bank	140	490.11
HSBC	18	467.58
JP Morgan Chase	14	377.23
Kotak Mahindra Bank	404	7,144.30
ICICI Bank Limited	338	6,830.91
Axis Bank Limited	356	5,121.48
HDFC Bank Limited	249	2,347.69
Federal Bank Limited	161	1,728.42

Effect of NPA on GDP growth ¶

How does rising NPA negatively impact GDP Growth? First, the banks inability to recover and realize assets result in write offs which leads to a decrease in their net profits. Second, the non-repayment of the loans by the existing borrowers prevents the banks from lending to new borrowers. This slows down the credit recycling and reduce the size of credit multiplier. Third, it impacts the banking morale and credit worthiness of the people resulting in defaults by even the honest borrowers. Fourth, it results in the lowering of the deposit interest rates by the banks to recover the bank loss from the depositors. On the contrary, the lending rates are increased by the banks that discourages the genuine borrowers from seeking loans and thereby affecting the economic productivity. Even more, the domestic businesses cannot survive in an environment where they pay higher interest for their borrowings while their global competitors are furnishing the loans at low rates. This results in negative balance of trade and large unemployment and social unrest.

A higher rate of NPA brings down the profitability of the banks leading to lower returns to the shareholders and investors. In the case of Public Sector banks, the biggest loss is to the Government as they are the biggest shareholders. Also the Government then has to infuse capital in the stressed banks with tax-payers money that causes further loss to the national exchequer.

The worst effect happens when NPAs force banks and financial institutions into liquidity crunch and they are no more able to finance good and necessary projects. The developmental work in infrastructure projects like roads, railways, airports, ports, electricity and drinking water may get stalled leading to an ultimate slowdown of the national economy.

Inferences ¶

1. The problem of NPA is much more acute in Public Sector Banks

The total NPA for public and private sector banks is around Rs 6 lakh Crore, as on June 2016. The amount
of top twenty NPA accounts of Public Sector Banks stands at Rs 1.54 lakh Crores. Indian Overseas Bank
has the worst NPA to Total Advances Ratio that stands at 20.26%. They are followed by UCO Bank (18.66%) and Bank of India (16.01%).

In absolute terms, State Bank of India has the highest value of Gross NPA at Rs 93,000 Crore. They are
followed by Punjab National Bank (Rs 55,000 Crores) and Bank of India (Rs 44,000 Crores). In comparison, private banks have lower NPA to Total Advances Ratio. The ratio for HDFC Bank is 1.07%, ICICI Bank Limted is 4.72%, IndusInd Bank is 0.92%, Kotak Mahindra Bank is 2.5% and Yes Bank is 0.82%. In absolute terms, the NPA is lowest for IndusInd Bank (Rs 861 Crores) and Yes Bank (Rs845 Crores).

2. The NPA situation in Public Sector Banks worsened after 2008

The Gross Non Performing Assets (GNPA) of Indian banks was Rs 53,917 Crore in 2008, just before the collapse of Lehman Brothers and the beginning of Subprime Mortgage Crisis. The bad loans have grown to touch Rs 3,41,641Crores in September 2015 and Rs 6,00,000 Crore in 2016. In other words the total GNPA as a percentage of total loans has grown from 2.11 percent in 2008 to 5.08 percent in 2015.

Surprisingly, before 2008, the Private Banks were in a worse condition with ICICI Bank being on the top. Now State Bank of India(SBI) and Indian Overseas Bank are at the top with the highest GNPA as a percentage of total loans percentage. This shows that while the Private Banks started cleaning up their balance sheets after the 2008 Crisis, the Public Sector Banks went for nondiscretionary lending leading to the ballooning of the crisis.

3. Nine out of the ten most stressed banks are Government Banks

The RBI had given a deadline of March 2017 to banks to clean up their balance sheet. This required the banks to set aside huge chunks of capital in provisioning of bad loans. On November 2016, SBI wrote off Rs 7,016 Crore worth of Non-Performing Assets (NPA) that was owed to it by 63 willful defaulters. Twenty nine state owned banks wrote off a total of Rs 1.14 lakh Crore of bad debts between financial years 2013 and 2015. SBI topped the list by writing off bad debts worth Rs 40,084 Crore in the last three financial years.

4. Loans given to Metal Companies, Textile Companies, Tobacco Companies, Gems and Jewelry Companies and Construction Companies carry the highest risk

Although Vijay Mallya and Kingfisher Airlines have been in the limelight for defaulting on outstanding
loans, the real villains are companies in the Metal, Textile, Tobacco, Gems and Jewelry and Construction Companies. Almost a third of all the outstanding advances (Rs 4.33 lakh Crores) given to Metal and Metal Product Companies turned to NPA (Rs 1.49 lakh Crore). Textile and Tobacco companies follow, both having NPA ratio of around 17%.

5. Private Sector Banks performed better than Public Sector Banks

The relative performance of Private Sector Banks during the period 2013 to 2016 was better than Public Sector Banks. As per data from RBI, the loans grew at 4% for Public Sector Banks while it grew 24.6%
for Private sector Banks Deposits at Government run banks grew by 5.2% while it grew 17.3% for Private
Sector Banks. The Net NPA grew by 6.1% for Public Sector Banks while it grew by 4.6% for Private Sector
Banks. In the fourth quarter of Financial Year 2015 (Q4 FY2015), 11 private sector banks posted a robust
35%rise in net profits while 10 Government run banks declared a 59% fall in net profits (Source: Business Standard, May 14, 2015).

Recommendations ¶

There are mainly three ways to reduce NPAs in banks. The first strategy is to negotiate with the defaulter and work out a mechanism to recover the bad loan. The second is to sell off the loan to a third party like an Asset Reconstruction Company(ARC) at a discount, who can recover the loan at a later period. Third is to increase the loan book size aggressively so that the NPA as a percentage to total loans look smaller.

One financial entity that has managed NPA in an admirable manner is Yes bank.They have the lowest NPA among all the banks in the country. On an absolute basis, the NPA at Yes Bank is only Rs 285Crore. The Gross NPA for the bank stood at 0.76% in March 2016 and Net NPA was at 0.29%. Yes Bank is a case study on how to keep NPA within controllable limits.

For the March 2016 quarter, Yes Bank reported a 30% YoY (Year-on-Year) growth in total revenue lead by a healthy growth in NII(Net Interest Income) at 27 percent YoY. The CASA (Current Account Savings Account) deposits have seen a growth of 28.1%. The Savings Account grew at 62%. The loan advances grew at the rate of 30 percent. These factors resulted in cost of funds for the bank coming down to 7.2% from 8.2% last year and post a strong Net Interest Margin (NIM) of 3.4 %.

Yes Bank has been successful in keeping the NPAs down because of a robust and stringent due diligence system. Yes Bank has created a structure which red flags a problem early and prompts the staff to take necessary action to control the damage. The Bank has created a risk culture and risk architecture where the relationship managers, product managers and risk managers look at a relationship from all angles which makes sure that when there is a problem, the red flag surfaces early enough. They have also diversified
their portfolio across different sectors to keep the risks low. Based on our research, we would like to offer the following recommendations to tackle the NPA problem in the country:

1.There is need for a strong and secure banking system to keep the momentum of growth on track.
2.The banks have to take extra measure on due diligence to prevent genuine loan amounts being passed on to customers with malafide intentions
3.The banks need to invest in technology like Big Data Analytics to analyze credit worthiness of customers before sanctioning the loans.
4.Banks need to go for robust risk management procedures that prevent manipulation from outside the system and from inside the system.
5.The creation of a ‘bad bank’ is an option that could be used to clean up the NPAs in the banking system.

References/Bibliography ¶

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APPENDIX ¶

List of Banks analyzed for conducting the Study

Sl. No.	Name of Bank	Sl. No.	Name of Bank
1	State Bank of India	26	State Bank of Mysore
2	Punjab National Bank	27	State Bank of Travancore
3	Bank of Baroda	28	HDFC Bank
4	Allahabad Bank	29	ICICI Bank
5	Andhra Bank	30	Axis Bank
6	Bank of India	31	Kotak Mahindra Bank
7	Bank of Maharashtra	32	Yes Bank
8	Canara Bank	33	ING Vysya Bank
9	Central Bank of India	34	RBL Bank
10	Corporation Bank	35	Federal Bank
11	Dena Bank	36	South Indian Bank
12	Indian Bank	37	IndusInd Bank
13	Indian Overseas Bank	38	KarurVysya Bank
14	Oriental Bank of Commerce	39	Jammu & Kashmir Bank
15	Punjab & Sind Bank	40	Lakshmi Bilas Bank
16	Syndicate Bank	41	Nainital Bank
17	Union Bank of India	42	Catholic Syrian Bank
18	United Bank of India	43	Karnataka Bank Limited
19	UCO Bank	44	Dhanlaxmi Bank Limited
20	Vijaya Bank	45	DCB
21	IDBI Bank Ltd	46	Citi Union Bank Limited
22	BharatiyaMahila Bank	47	Capital Local Area Bank Limited
23	State Bank of Bikaner & Jaipur	48	Tamilnadu Mercantile Bank
24	State Bank of Patiala	49	Coastal Local Area Bank Limited
25	State Bank of Hyderabad	50	Krishna BhimaSamruddhi Bank

Figure-Banking structure in India

Different offerings by banks:

Retail Banking

Loan products	Deposit products	Other offerings
Auto & Personal Loans	Saving Accounts	Depository Accounts
CV & Construction Equipment Finance& Gold Sales	Current Accounts	Mutual Fund, Insurance
Credit / Debit Cards	Fixed / Recurring Deposits	Private Banks
Loan against gold	Corporate & Salary Accounts	NRI, Bill Payment & Forex
Agriculture & POS Terminals	Tractor Loans	Educational Loans

Wholesale Banking

Commercial banking	Transactional banking	Investment banking
Working Capital & Term Loans	Cash Management	Debt Capital Markets
Bill collection Bank services	Custodial & Clearing	Equity Capital Markets
Wholesale deposits	Correspondent Banking	Project Finance
Forex & Derivatives	Tax Collections	M&A and Advisory‘
Letter of Credit	IPO Underwriting

Treasury Operations

Treasury Products	Other Functions Offerings	Other Banking Activities
Forex	Asset Liability Management	Leasing Operations
Debt Securities	Statutory Reserve Management	Dealership Business
Equities & Derivatives		Third Party Product Distribution